On Friday, December 22, 2017, the President signed into law the tax reform legislation that had been referred to as the “Tax Cuts and Jobs Act” (TCJA). Below are many of important changes which will impact most businesses. It is important to note that most corporate provisions in the bill are permanent, while some other business provisions expire after December 31, 2025.
TAXATION OF CORPORATIONS
- Tax rates: The corporate tax rate has been reduced to a flat rate of 21%, effective for tax years beginning on or after January 1, 2018. This includes personal service corporations.
- Alternative minimum tax: The corporate AMT has been repealed.
- Net operating losses: Net operating loss deductions are limited to 80% of taxable income, determined without regard to the deduction, for losses generated in taxable years beginning after December 31, 2017. NOLs may only be carried forward, indefinitely.
- Dividend received deductions: The 70% and 80% dividend received deductions for corporations have been reduced to 50% and 65%, respectively.
- Foreign taxes: A one-time repatriation tax of 15.5% for liquid assets and 8.0 percent for illiquid assets is imposed on earnings from overseas. Furthermore, a complex new system for international taxation is being implemented.
TAXATION OF PASS THROUGH ENTITIES
- Qualified business income deduction: Non-corporate taxpayers (such as partners and shareholders of S corporations and LLCs) may generally obtain a deduction equal to the lesser of 20% of qualified business income or 50% of the W-2 wages with respect to the partnership or S corporation. For taxpayers in a specified service trade or business (e.g., law, accounting, consulting, financial services), no deduction is permitted unless their taxable income is less than $157,500 ($315,000 if married filing a joint return).
- Technical terminations: The technical termination rules are repealed for tax years beginning after 2017. No changes are made to the actual termination rules.
- Capital gains: Under general rules, gain recognized by a partnership upon disposition of a capital asset held for at least one year is characterized as long-term capital gain. Further, the sale of a partnership interest held for at least one year will generate long-term capital gain with some exceptions. Long-term capital gain will only be available with respect to “applicable partnership interests” to the extent the capital asset giving rise to the gain has been held for at least three years.
- Built-in gains tax: The built-in gains tax will apply at the corporate tax rate of 21%, effective for tax years beginning after January 1, 2018.
BUSINESS EXPENSES AND DEDUCTIONS
- Qualified Production Activities: The new law repeals the deduction for qualified domestic production activities previously allowed. This applies for corporations and owners of pass-through entities.
- Interest deductions: For most taxpayers, the limitation on net interest expense deduction will be 30% of adjusted taxable income. The business interest deduction is limited to the sum of (1) business interest income, (2) 30% of the taxpayer’s adjusted taxable income, and (3) the floor plan financing interest of the taxpayer for the taxable year. Disallowed interest will have an indefinite carryforward period. Small businesses with less than $25 million in annual gross receipts over a three-year period are exempted from the interest limitation.
- Like-kind exchanges: Like-kind exchanges under section 1031 will be limited to real property that is not held primarily for sale. The like-kind exchange rules will no longer apply to any other property, including personal property that is associated with real property. This provision generally applies to exchanges completed after December 31, 2017. However, if a taxpayer has started a forward or reverse deferred exchange prior to December 31, 2017, section 1031 may still be applied to the transaction.
- Entertainment expenses: The deduction for business-related entertainment is repealed. No deduction is allowed for entertainment, or recreation activities, facilities, or membership dues related to such activities.
- Meals expenses: Entertainment meals are non-deductible. Taxpayers can still generally deduct 50% of the cost of qualified meals associated with operating a trade or business. Meals incurred on business travel are 50% deductible. Deduction for meals provided on or near employee’s premises (considered to meet requirements for de Minimis fringes) for convenience of the employer reduced from 100% to 50% for amounts paid or incurred after December 31, 2017, and until December 31, 2025. Such amounts incurred and paid after December 31, 2025, will not be deductible.
COST RECOVERY PROVISIONS
- Bonus depreciation: Property defined under section 168(k), acquired and placed in service after September 27, 2017, and before January 1, 2023, is allowed a 100% deduction for the taxable year in which the property is placed in service. The 100% allowance is phased down by 20% per year for property placed in service after January 1, 2023 (80% for 2023; 60% for 2024; 40% for 2025; and 20% for 2026). Property eligible for bonus depreciation has been expanded to include used property.
- Luxury car rules: Annual depreciation limitations for luxury automobiles under section 280F have been increased to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year, and $5,740 in the fourth and later years. The new limitations apply for automobiles placed in service after the 2017 tax year.
- Listed property: Computer or peripheral equipment is removed from the definition of listed property and no longer subject to the heightened substantiation requirements currently required.
- Section 179 deduction: Under section 179, business taxpayers may elect to deduct the cost of qualifying property with an annual limit of $1 million for tax years beginning in 2018 (2017 limit is $510,000). The $1 million limitation is reduced by the amount of which the cost of the property placed in service during the taxable year exceeds $2.5 million (2017 phase-out starts at $2,030,000). These amounts will be indexed for inflation after 2018. The section 179 definition of qualified real property is expanded to include improvements to nonresidential real property including roofs, heating, ventilation, air conditioning, fire protection, alarm systems, and security systems.
- Qualified improvement property: The definition of qualified improvement property eliminates the separate definitions for “qualified leasehold improvement,” “qualified restaurant property” and “qualified retail improvement property.” The 15-year recovery period remains unchanged.
- Expanded Use of the Overall Cash Method of Accounting: The gross receipts threshold that exempts certain taxpayers (C corporations, partnerships with C-corporation partners and tax shelters) from the requirement to use accrual method of accounting was increased under the tax reform bill from $5 million under current law to $25 million for taxable years beginning after December 31, 2017.
- Accounting for Inventories: Starting with years that begin after December 31, 2017, businesses that fall under the $25 million gross receipts threshold will not have to compute section 263A, and can treat inventory as non-incidental materials and supplies (i.e., deduct in the year the materials and supplies are used/consumed), or conform to the taxpayer’s method of accounting reflected in an applicable financial statement or books and records.
- Expansion of exemption from Percentage of Completion Method: The new law expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the provision, contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected to be completed within two years of commencement of the contract and (2) is performed by a taxpayer who meets the $25 million gross receipts test.